Ideas for Intelligent Investing

The end of value investing?

One of the blogs I have been following is called Greenbackd: Undervalued Asset Situations with a Catalyst. They do a nice job of covering traditional “Ben Graham” type stocks where the entire company sells at a discount to its net asset value. They like situations where an activist value-oriented investor is involved to help insure that assets are not dissipated by a management team that is more interested in lining its pockets than unlocking value.

In a recent post they respond to an article in The Atlantic called “What Would Warren Do?” , which argues that technology and widespread and immediate access information has eroded, if not eliminated, much of the edge of value investors.

“Megan McArdle has written an article for The Atlantic, What Would Warren Do?, on Warren Buffett and the development of value investing, arguing that better information, more widely available, will erode the “modest advantage” value investors have over “a broader market strategy” and Warren Buffett’s demise will be the end of value investment. We respectfully disagree.

The article traces the evolution of value investing from Benjamin Graham’s “arithmetic” approach to Buffett’s “subjective” approach. McCardle writes that the rules of value investing have changed as Buffett – standard bearer for all value investors – has “refined and redefined” them for “a new era”:

“When Benjamin Graham and David L. Dodd wrote the value-investing urtext, Security Analysis, in 1934, the rules were more hard-and-fast. Graham and Dodd looked for companies whose price was less than their intrinsic value, and offered various formulas for divining this value.

Buying stock in firms where the intrinsic value of the assets is higher than the market capitalization worked well in the depths of the Great Depression, when investors were wary of holding equity. Between 1929 and 1932, the Dow lost just about 90 percent of its value, bottoming out at 41.22. What economists call the “equity premium”—the extra return that investors demand to compensate for the risk of holding stocks—has never since been so high. That’s why Graham and Dodd could find companies whose liquidation value offered a substantial “margin of safety” for people who bought their equity.

Moreover, book value and other balance-sheet-based metrics have become less useful, as the market, and the economy, have changed. Persistent inflation means that the historical cost of the assets on the balance sheet in many cases bears only passing resemblance to their actual worth. Meanwhile, firms get more and more of their value from intangible assets, like intellectual property or strong brands, that don’t show up in the financial statements. Geico, one of Buffett’s crown jewels, gets much of its value not from physical equipment or even investment savvy, but from a sterling brand name built on relentless advertising.”

McCardle says that the rules have changed so much that Graham’s approach no longer offers any competitive advantage:

“Much of what Graham and Dodd did so well was simply hard coolie labor. In an era before spreadsheets or financial databases, they looked at company reports and painstakingly did the arithmetic to see where a company stood. That effort offers no competitive advantage in today’s information-saturated market. So while value investors still hew to the core notion of determining a company’s intrinsic value, waiting for the market to misprice the stock, and then buying on the cheap, nowadays that determination has much more of a subjective skill element.” [Continue reading]

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